Dollar gains on interest-rate benefit

Limited bounce for euro from German leadership deal

By

RachelKoning

CHICAGO (MarketWatch) - The dollar gained against the euro Monday as the formation of a governing coalition in Germany - the only feasible end to a three-week post-election stalemate - was seen hampering efforts to bring about changes some see necessary to revitalize economic growth in the country and the euro region.

"The market is skeptical about the effectiveness of the grand coalition government and the euro is unlikely to receive any long-term benefit from this outcome until both parties can demonstrate to the world that they will set aside their partisan differences and will legislate in a business-like manner," said analysts at U.S.-based currency firm Forex Capital Markets.

Uncertainty about economic growth in the euro-zone's largest economy -- German second-quarter GDP was flat, but more recent business and consumer indicators have been positive -- comes amid the near certainty that U.S. interest rates will have to head higher to fend off post-hurricane inflation risks.

Higher rates are seen keeping the dollar trading at a yield advantage to the euro, yen and other leading currencies, by keeping up the inflow of foreign money into U.S. markets. U.S. benchmark rates already stand at 3.75% compared with the European Central Bank's 2%, for instance.

More clues on the course for interest-rate action when the Fed next meets Nov. 1, and beyond, could come in Tuesday's release of meeting minutes from the central bank's gathering on Sept. 20. See Economic Preview.

Thin conditions also accounted for a relatively unobstructed path higher for the dollar, traders said. U.S. bond markets were closed Monday for the Columbus Day holiday, while Canadian and Japanese financial markets were also shut for holidays.

In late-day U.S. trading, the greenback was 0.5% higher against the euro compared with where it stood late Friday. The euro was quoted at $1.2066 vs. $1.2123.

The dollar was changing hands at 114.12 yen compared with 113.75 yen late Friday. That accounts for a 0.3% gain on the day. The dollar touched 114.40 yen last week, its highest in some 16 months.

The dollar gained 0.2% against the British pound; sterling was quoted at $1.7562 compared with $1.7605 Friday.

Coalition or stalemate?

The euro did get a short-lived boost after Chancellor Gerhard Schroeder said he will turn over Germany's leadership to rival Angela Merkel. The end to a three-week deadlock that followed the closest national contest since World War II did bring some stability to the currency.

Merkel said she will preside over a cabinet balanced between center-left and center-right ministers in what the parties themselves have coined a "grand coalition."

It's just that prospect that returned the common currency to its defensive trading; the inability to pass sweeping labor or regulatory changes could weigh on growth, according to some observers. Certainly, currency markets view such a challenge as mostly euro-negative.

But the Forex Capital analysts said markets shouldn't dismiss the German agreement so easily.

"We are actually more optimistic than the consensus view about the possibility of coalition rule," they said. "Germany is clearly in need of serious restructuring and with neither the far right, nor the far left able to sabotage the reform agenda, the two mainstream parties may just be able to create a workable plan of action."

The Christian Social Union's head, Edmund Stobier, is widely expected to become economics minister, while the SPD is expected to get to name the foreign minister and finance minister. Overall, the SPD is expected to have more ministries than Merkel's CDU/CSU alliance. See full story.

Delayed reaction

Some traders said the dollar's gains could be pinned on a late response to last week's U.S. employment data.

They argue the currency market didn't get to fully respond to much better-than-expected U.S. payrolls - down 35,000 after Katrina instead of the 150,000-plus expected -- in part because traders were distracted by lingering terrorism worries after reported threats to the New York subway system. See Economic Report.

Tuesday's Fed meeting minutes are expected by a majority of currency analysts to continue the hawkish theme present in most recent U.S. central bank speeches.

"The dollar continues to build on recent gains after further comments from the Fed at the end of last week suggested once again that there's going to be no let-up in the hawkish stance over interest rates," said Paul Jackson, currency dealer with CMC Group.

"Oil prices are also retreating and although we're still holding clear of the $60 level, again this starts to remove some of the pressures associated with the wider trade deficit."

The U.S. is a net importer of oil; crude's monthly price fluctuation can wield much impact on the trade results.

On Monday, lead-month natural-gas futures traded as low as $12.70 per million British thermal units, their lowest since late September. The contract is down more than 3% on the day. November-dated crude was as low as $60.77 a barrel, its lowest since late July. See Futures Movers.

The challenge presented the United States in drawing enough foreign investment to offset a record trade gap was one of the chief factors behind the dollar's three-year tumble through late 2004.

Intraday Data provided by SIX Financial Information and subject to terms of use.
Historical and current end-of-day data provided by SIX Financial Information.
All quotes are in local exchange time. Real-time last sale data for U.S. stock quotes reflect trades reported through Nasdaq only.
Intraday data delayed at least 15 minutes or per exchange requirements.